The ruling issued by the Tel Aviv District Court in October 2025, in the case of Hexadite Ltd. v. Tel Aviv 3 Tax Assessor, establishes fundamental criteria on the valuation of intellectual property (IP), the treatment of conditional payments (“holdbacks”) and the application of secondary adjustments in transactions between related parties following an acquisition. This decision sets a benchmark for transfer pricing practices in corporate restructuring processes and intangible asset transfers within multinational groups.
Case Context
The case of Israel v. Hexadite Ltd. arose following Microsoft’s acquisition of the Israeli cybersecurity company in 2017 for approximately USD 75 million, which included initial payments and holdbacks subject to the retention of key personnel. After the purchase, Hexadite transferred its functions, assets, risks, and intellectual property to Microsoft, declaring a value of USD 65.4 million for tax purposes.
The Israel Tax Authority (ITA) questioned this valuation, arguing that the holdbacks should have been part of the total transfer price and that a gross-up tax should have been applied to accurately reflect the tax base. It also imposed a secondary adjustment for interest, considering that there was unpaid consideration between the related parties.
This case is relevant because of its impact on the valuation of intangibles, the inclusion of withheld remuneration, and the interpretation of deferred payments in international technology transactions.
Applicable Regulatory Framework
The court analyzed the case under:
- The OECD Transfer Pricing Guidelines.
- Israeli regulations applicable to corporate restructuring, including administrative circulars on:
-
- Transfer of assets and functions (FAR).
-
- Valuation of intangibles in transactions between related parties.
- Principles of the Comparable Uncontrolled Price (CUP) method as the main reference in valuations derived from independent market transactions.
The use of the purchase price of shares by Microsoft—an unrelated party—as a comparative reference was particularly relevant to the judicial analysis.
Technical Issues in Dispute
The case presents a number of technical controversies relevant to transfer pricing practice, particularly in the valuation of intellectual property and the tax treatment of deferred payments in acquisition processes. The main points in dispute were as follows:
1. Inclusion of a “tax gross-up” in the valuation of IP
One of the main questions was whether the valuation of intellectual property (IP) should be increased to reflect the tax burden associated with the intra-group transfer. The ITA argued that, since corporate income tax had not been considered in the calculation of the transfer value, a tax gross-up should be applied, i.e., the declared value should be adjusted to reflect the amount that the company would have received before taxes. Under this logic, the underlying economic valuation would increase significantly.
Hexadite, for its part, argued that Israeli law did not require such an adjustment for intra-group intangible asset transfers and that the agreed economic value already reflected the actual consideration accepted by the parties.
The debate raises a key question: whether or not corporate tax should form part of the market value of the transaction, an issue that has not been extensively addressed in Israeli case law.
2. Tax treatment of holdbacks subject to permanence
The transaction included holdbacks that would only be released if the founders remained employed for a period of three years. The discussion revolved around their tax nature:
- For the ITA, the holdbacks were part of the total price paid by Microsoft for the acquisition of Hexadite, as the buyer benefited from the value generated by retaining the key team that developed the technology.
- For Hexadite, these amounts constituted salary compensation conditional on continued service, so they should not be treated as part of the transfer price of the IP or the shares.
This point is critical, as the classification of holdbacks affects the determination of the value of the intangible asset, the timing of recognition, and the associated tax burden. The discussion is also linked to principles such as the benefit test, the economic substance of the payment, and the separation between what constitutes purchase price and what constitutes employment compensation.
3. Secondary adjustment and interest on the deemed loan
After determining a value higher than that declared by Hexadite, the ITA applied a secondary adjustment, interpreting the difference between the two values as a fictitious debt (deemed loan) granted by Hexadite to its foreign related party.
Following this logic, the tax authority charged interest on this debt, applying a high interest rate, which substantially increased the final amount of the adjustment.
Hexadite challenged this approach, arguing that there was no actual financial transaction or intra-group loan, and that the application of a deemed loan was inappropriate when the dispute centered on the valuation of the IP and not on a failure to collect.
The treatment of secondary adjustments is a matter of international debate. Some jurisdictions apply them automatically; others consider it inappropriate when the difference arises exclusively from valuation criteria and not from intragroup financing.
Court Decision
The Israeli District Court’s ruling provides important guidance on the application of transfer pricing in intangible transfer transactions and on the tax treatment of deferred payments associated with technology acquisitions. The ruling addresses three key aspects: the use of tax gross-up, the tax nature of holdbacks, and the treatment of secondary adjustments.
1. Rejection of tax gross-up
The court rejected the ITA’s proposal to increase the valuation of the IP by applying a tax gross-up, arguing mainly that:
- The CUP method does not require future taxes to be incorporated into the market value.
Given that Hexadite’s analysis was based on a comparable approach (Comparable Uncontrolled Price), the court held that this method is used to compare prices between independent transactions without introducing adjustments for future tax burdens, as these depend on the particular structure of the taxpayer and not on the economic value of the asset.
- The purchase price already reflects the economic expectations of the parties.
The court emphasized that Microsoft, as an independent buyer, agreed to pay the agreed price for the company and its intellectual property, which shows that this consideration incorporated all the elements of risk and expected returns without the need to inflate the value for tax purposes.
- The ITA cannot reinterpret its own guidelines without prior notice.
The court was clear in stating that the tax authority cannot retroactively modify the application of its transfer pricing guidelines without formally communicating a policy change to taxpayers. In this case, the ITA presented the gross-up as standard practice, when in fact there was no such precedent or explicit regulatory provision.
Result: The tax gross-up should not be included in the valuation of the IP or FARs transferred by Hexadite.
2. Inclusion of holdbacks in the total consideration
With regard to holdbacks, the court concluded that these were part of the total transfer price for the following reasons:
- The holdbacks were linked to shareholder status, not just to dependent work: Although the amounts were conditional on the founders remaining as employees, the court noted that the primary economic purpose was to ensure that those who developed the technology would accompany the transition of the business to Microsoft. This connection between permanence and transfer of shareholder value indicates that the holdbacks were part of the acquisition price.
- The trust structure reinforced their nature as consideration: The retained payments were deposited into a trust chosen by the founders themselves, which significantly reduced any argument about collection risk or uncertainty in the amount. For the court, this configuration was consistent with a deferred distribution mechanism of the sale price, not with an employment bonus.
Result: The holdbacks must be added to the value of the transfer of the IP and the functions, assets, and risks (FAR).
3. Secondary adjustment and market value interest rate
The court accepted the concept of secondary adjustment, considering valid the interpretation that the difference between the declared value and the value determined by the ITA can generate a fictitious debt (deemed loan) between related parties. However, it made important clarifications:
- It rejected the interest rate proposed by the ITA as disproportionate: The authority had applied a significantly high rate, without adequate support in market comparables or actual intragroup financing conditions.
- It ordered the use of a rate based on actual loans within the Microsoft group: The court determined that, in the case of a deemed loan within the same conglomerate, the rate should reflect the observable financing cost in comparable intragroup transactions. This decision reinforces the arm’s length principle applied consistently with internal evidence from the multinational group itself.
Result: The secondary adjustment is maintained, but with an arm’s length interest rate consistent with actual intra-group loans within the Microsoft group.
Conclusion
The Hexadite vs. ITA case sets a key precedent in the valuation of intangibles and the tax treatment of deferred payments in technology acquisitions. The court reaffirms that the valuation must reflect actual economic conditions, that holdbacks must be analyzed according to their true economic nature, and that the tax authority must apply consistent and transparent criteria. Its relevance transcends Israel, offering useful guidelines for other jurisdictions aligned with the OECD.
Do you need advice on transfer pricing?
At TPC Group, with a presence in Latin America, the United States, and Spain, we have a team specializing in documentation, intangible asset valuation, FAR analysis, and technical defense in audits.
We can help you anticipate risks, optimize your tax position, and strategically manage any transfer pricing disputes.
Source: TPCases